Financial Acumen, Market Correlation and Hive
Financial Acumen, Market Correlation and Hive
The year 2022 have not been kind to the markets. I am talking about both stock markets and crypto. After the all time high in Nov 10, 2021, at nearly $69K, we all know BTC sold off, and at $34K after nearly 6 months, it is down just more than 50%. Comparatively, S&P 500, the bencemark of US stock market, put on a high on Jan 04, 2022, just north of 4800, and currently after 5 months, it is down just more than 15% at about 4100. These are facts. So the question is how do we analyze this?
I put both charts side-by-side for a simple visual correlation. Often human eye is the best analyzer compared to any automated technique. We can see, althrough the ATH was slightly offset but the downturn is surprizingly similar, albeit, at a different percentage as I mentioned above. Actually if I do a like-for-like comparision, and check the BTC price on Jan 04, 2022, at the high of the stock market, BTC decline is about 30% (28% to be more precise). So BTC decline is about 2X the decline of the stock market during similar time period.
Correlations are at All-Time-High!
Here is the problem. A good investor always look for alternative assets. Meaning assets with low and perhaps negative correlation with the stock market. BTC used to provide that solution perfectly, as shown this recent IMF blog, that the correlation between BTC and the Stock market used to be low, especially during 2017-18 during the early adaptation of BTC. Most of the 2017-18, the correlation between BTC and S&P 500 was in the order of 0.0 - 0.3, sometimes even -0.2! Negative correlation was typically consider juicy hedge for a portfolio highly correlated to the stock market. But alas, those days are long gone!
Below is the current correlation between BTC and S&P 500 over a rolling 60D window. Currently it is at 0.7! Just for reference 1.0 will be a perfect correlation, it will be like an index fund or ETF (SPY). This is an unreal correlation for something that is typically called 'alternative investment'.
Therefore, the obvious conclusion is that BTC is NOT an alternative investment anymore. Just like most things in the present world, it will go up and down with the stock market and the general economy. If that is the case, to understand and predict the downturn and end of it, we must use the same forward looking tools that we use for the general stock market and the economy.
Inversion of the Yield Curve
For the stock market there are very limited number of forward looking indicators available. Yeah, please don't tell me technical analysis of a chart can predict the future move of the market. I have used technical analysis for 30 years and I can tell you that it is an useful tool but predicting market move is not the main use of them :)
One of the tools that can predict the market moves, more precisely a particular move, the one we are currently interested in: RECESSION; is the US Tresury Yield Curve, or more precisely the inversion of the yield curve. It is one of the best forward looking indicator of the recession of the stock market.
First, What is a yield curve?
A yield curve is a graphical representation of yields on bonds with different maturities.
The government bond yield curve is often referred to as the benchmark yield curve. Each day, the US Department of the Treasury (www.treasury.gov) reports the yields for various maturities of US government bonds, ranging from 1 month up to 30 years.
Second, What is a Normal yield curve, and what is an inverted yield curve?
Generally speaking a yield curve reflect peoples collective perception of risk. In a normal scenario, people typically expect higher compensation (yield, interest) to invest money in bonds for longer duration. Meaning a shorter maturity (say 6- month) US Govt. Bond will have lower interest (yield) compared to a longer maturity bond (say 30 - Year).
An inverted yield curve happens where shorter dated Govt. Bond yield higher interest rate compared to longer dated bonds. This means investor are afraid to invest money longer term and like to keep it all in cash or equivalents. An inverted yield curve is a rare event and typically widely talked about in the financial media. An inverted yield curve usually begins with flattening of the longer duration yield and typically is never completely inverted. However, even a slightly inverted yield curve is enough to trigger a recession. Important to note: Yield curve inversion is forward looking, and happens before the recession, and it has correctly predicted the last 7 recessions.
There is a nice animation of historical yield cuves can be found here:
So: Now What?
Yes, the million dollar question. My working hypothesis this to predict the recession based on the shape of the yield curve. This is not a rocket science (I will also argue that rocket science is not particularly hard!). Below is the current yield curve for US Treasuries. We can see the flattening past 3-Years as Fed continue to rise interest rate and signal further rise (which is a fine thing to do, to manage inflation). There is a slight inversion at the longest duration between 20-to-30-Years.
So this this typically the early sign. Market is smarter and smarter these days. Everyone have access to this data. Market is forward looking to the n-th degree, so it has already beginning to price-in the downturn (recession?)!
Is there a silver lining? Yes, there is a myth in financial system, called 'soft landing'. Meaning, raising the interest rate gently enough so that not to trigger the inversion and therefore a recession. It is very hard to accomplish. All these respected people tried, none succeeded!
I am a big fan of Ben Bernanke, the depression scholar, and even he couldn't pull it. So I don't think, I have very high hope that we can pull it this time. If recession happens we are looking at 40%-60% further decline, if it is deep. If it is shallow, then 15% - 40% further decline of the stock market. Which is really no big deal in either scenario. Just keep cash and you will be fine!
Based on the current correlation of the market to BTC, if market drops 40% from here, BTC probably not going to drop 80%, simply because, lower it dips, lesser the correlation. But just saying, $10K BTC on a spike low is always a possibility. I have the cash ready to buy if that happens.
Oh! I am keeping my hive powered up as an inflation hedge and some income and looking to buy more hive if the price declines further.
Disclaimer: This is NOT professional advice, this is all just my own opinion and experience. I am NOT a Certified Financial Adviser. Consult professionals for any financial, accounting or legal related questions you have.
Charts are created in Tradingview.com, which is a free service.